Surety: Contractors Face Labor Shortage as Soft Market Reigns

How familiar are you with the kinds of factors that often lead to surety claims?

Perhaps poor accounting and cost control systems are in place—a recipe for disaster considering that contractors are processing more transactions in light of the recent increase in construction activity.

Or perhaps the contractor or project owner simply took on a project that is larger and more complex than their past work experience.

“It is widely recognized that larger projects stretch resources and technical abilities,” says Tad Nelson, regional underwriting officer for Bond & Specialty Insurance Construction Services at Travelers. “As underwriters, we believe decisions made on these larger projects require a certain level of experience and knowledge.”

That’s an especially important observation in the midst of an ongoing labor shortage in the construction market, which Nelson says “continues to put pressure on project scheduling and costs” for contractors.

Although Nelson notes that the construction industry has been working hard to attract talent by highlighting the needs and attributes of the industry and that recruiting at the high-school level has grown over the last 12-18 months, “the biggest issue for contractors is that they’re all struggling to find skilled labor,” says Jack Anderson, president of Goldleaf Surety.

While the costs associated with labor and material have increased, “contractors have not seen a proportionate increase in their gross profit margins,” Nelson explains. “Analyzing the upward trend in backlogs and annual revenues, you’d see close to double-digit growth rates. However, if you track the movement in average gross profit margins over that same time, you will probably see only a low single-digit advancement. The gross profit margins have not returned to their prerecession levels.”

In other words, “even though the economy supposedly is doing good, there are still plenty of contractors that are not making really good money,” Anderson says. “It’s not all roses.”

But for contractors who are struggling to manage scarce resources, the surety market, at least, offers good news. “Claim activity is having little effect on changing terms and conditions,” Nelson says. “The majority of the market is still operating profitably and looking for additional market share. Soft market conditions have continued in 2019.”

“It’s just crazy out there,” Anderson agrees. “There have been some bigger losses, but it really hasn’t changed how aggressive the surety industry is. For now, people are willing to provide just unbelievable rates and unbelievable bond programs.”

Why haven’t losses moved the market? Part of the problem, Anderson says, is consolidation within the surety industry. “When you see the big boys buying up smaller sureties, they all have a bigger appetite, and they’ve got to keep growing to justify the acquisition,” he explains. “As long as that scenario continues, the market is going to stay soft for a while.”

But what “a while” means could be anybody’s guess, cautions Anderson, who points out that surety tends to follow a 10-year cycle. “We’re almost through that cycle,” he says. “Does that mean the market is potentially going to be changing in the next two or three years? It depends on what happens to the economy, how many hits the surety industry takes—a lot of factors will impact how drastic of a change it’ll be.”

With economists predicting a slow-down in the housing market as early as next year, “that could be another reason for a change, since commercial construction usually lags behind housing,” Anderson adds. “When? I don’t know. Nobody really knows, but if the surety market started to harden soon, it wouldn’t surprise anyone.”

Jacquelyn Connelly is former IA senior editor.